November 2016 IssueLong scroll reading

Priceless – Worth Absolutely Nothing!

By Edward A. Studzinski

“Under this flabby exterior is an enormous lack of character.”

  Oscar Levant

This has proven a rather difficult time to write something and feel that you are either (a) not repeating things you have said before or (b) speaking with the certainty that you are offering some genuine insight that will prove advantageous to our readers as they pursue their investment programs. For those reasons, I will endeavor to be brief, which will probably result in my being more obscure in my comments than usual. I offer thus a number of random thoughts which should hopefully raise questions without providing any answers.

A friend of mine in the public finance/investment banking business attended a conference on private equity investments recently. The takeaway was that some eighty per cent of private equity funds are finding their new investments by purchasing them out of existing private equity funds that have a need, as limited life funds, to liquidate investments. Thinking this a little strange, as I had recently heard a Boston-based investment consultant recommending that endowments in particular should increase their allocations to private equity, I raised the question with a Boston-based hedge fund manager with a superb long-term record. His response – yes, we are seeing musical chairs being played now. It will be interesting to see what happens when the music starts to slow more than just incrementally. The other question this begs is the potential for having rather subtle conflicts of interest when your endowment committee consists of too many private equity managers from the same community or same part of the country, where both fee structures and business models suffer from a distressing sameness.

The question I would ask is whether we are seeing the same madness in the public investment arena? With the increase in assets held in index funds, where the shares are purchased and sit unless the funds are hit with redemptions or the composition of the index changes, are the so-called active managers, especially the closet indexers (see this weekend’s excellent article on that group by Jason Zweig in the Saturday Wall Street Journal) also engaged in a game of musical chairs. And what of those mutual fund portfolio managers who adhere to a strategy of “regression to the mean” investing? A corollary question – is a regression portfolio manager worth eighty or ninety basis points as a fee?

The great unanswered question of course is whether interest rates are finally due to increase (by themselves) or as a result of the decisions of the Federal Reserve. I am one of those who thinks that the Fed waited far too long to raise rates, and has done immeasurable and lasting damage to the savings of middle class Americans. This was all done in the name of stimulating employment in a weak economy. Unfortunately that was done without thinking through what kind of job creation we needed in a twenty-first century economy. So the Fed is left without a lot of wiggle room if the domestic economy does fall off a cliff in the next twenty-four months.

Finally, we have the play out of BREXIT as well as our Presidential Election. Much has been written about BREXIT and what it means to Britain’s economy and that of Europe. I don’t think anyone knows the answer now, after four months going on five. I doubt that anyone will know the real answer for at least another five years. So perhaps there should be a focus on those things that are not so much luxuries that are in occasional demand, but rather the necessities of everyday living (or national survival, such as national defense).

Which brings me to our election? Other than uncertainty, who knows? What does it mean? I doubt very much we will know for some time. We are faced as they say, with choosing the evil of two lessers. It was reassuring to see, again in the weekend Wall Street Journal, that we have been through such contentious periods before. If anyone doubts that, they should research the election pitting Andrew Jackson against John Quincy Adams. It was decided by the House of Representatives. And if we survived that, we should be able to survive what we may face in coming days.

Which leaves me with the question of how to invest at this point in time? My primary suggestion is that you avoid the conventional wisdom. Look for investments that are uncorrelated with other investments. I still consider cash to be the undervalued and underappreciated asset. And indeed, as fears of the ability of money market funds, especially in the tax exempt area, to break the $1 price per share have surfaced, investors had briefly been presented with some greater arbitrage opportunities than they have seen in recent years, assuming those same money fund managers did not raise their fees back to recoup lost income. Bonds, except for the very short-term ones, should be avoided. And equities range from fair to over-valued, so tread very carefully and understand what you own. And also understand whether the equities you own represent a large and constituent weighting part of indices such as the S&P 500.

Good luck!

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About Edward A. Studzinski

Ed Studzinski has more than 30 years of institutional investment experience. Until January of 2012, he was a partner at Harris Associates in Chicago, Illinois. Harris is known for its value-oriented, bottom-up investment approach that frames the investment process as owning a piece of the business relative to the business value of the whole, ideally forever. At Harris, Ed was co-manager of the Oakmark Equity & Income Fund (OAKBX). During the eleven plus years that he was in that role, the fund increased more than 35 times in size. Concurrently Ed was also an equity research analyst, providing many of the ideas that contributed to the fund’s success. He has specialist knowledge in the aerospace & defense, financial services, and spirits & tobacco industries, having followed and owned companies as diverse as Alliant Techsystems, Catellus Development, GATX, General Dynamics, InBev, Kirby, Legacy Hotels, L-3, Nestle, Partner Re, Philip Morris International, Progressive Insurance, Rockwell Collins, Safeco Insurance, Teledyne, Textron, and UST. Before joining Harris Associates, over a period of more than 10 years, Ed was the Chief Investment Officer at the Mercantile National Bank of Indiana, and also served on their Executive and Asset-Liability Committees. Prior to Mercantile, Ed practiced law. A native of Peabody, Massachusetts, he received his A.B. in history (magna cum laude) from Boston College, where he was a Scholar of the College. He has a J.D. from Duke University and an M.B.A. in marketing from Northwestern University. A Chartered Financial Analyst, Ed belongs to the Investment Analyst Societies of both Boston and Chicago. He is admitted to the Bar in Illinois, the District of Columbia, and North Carolina.